Category: Uncategorized

Now I never said that Music Modernization Act was a self-licking ice cream cone. That was someone else. Neither did I say it was the gift that keeps on giving. That wouldn’t have been me–it’s just getting started, after all. Too soon.

We are now having a look at the first of what will no doubt be many, many regulations to be issued by the Copyright Office that will actually implement the MMA. Wakey wakey.

Thanks to Senator Ron Wyden’s last minute looney tunes shakedown when the MMA was limping across the finish line in the Senate, the Copyright Office has circulated a notice of inquiry for the first MMA regulations promulgated by the Copyright Office. This time it’s regulations under Title II of the MMA for the new “license” request for “noncommercial” uses of pre-72 sound recordings. Never heard of this “license” before? Didn’t know it was in the MMA? Get used to it. If you’re like most people, you didn’t read the 200 page MMA before it passed, but you would do well to read it very carefully now that it is the law of the land.

The coming wave of regulations to be released by the Copyright Office will be your last chance to eject from the twilight zone–but file it under “M” for “maybe”. Because the die is cast and the Rubicon is crossed.

It must be said, of course, that the only reason we are having this discussion is because Google’s data farming Senator Ron Wyden threatened to put a hold on the MMA literally at the 11th hour and conducted an entirely predictable but no less grotesque legislative shakedown that is so typical of his Wydeness.

This didn’t come from the members of the House of Representatives who voted unanimously for the pure CLASSICS Act and it didn’t come from the other 99 members of the Senate who would have voted for the same House bill. No, this came from Senator Wyden and his motley crew from Public Knowledge, aka the Google shillery, the nutty professors and, we must assume, with the blessing of at some of the members of the Digital Media Association.

I want you to remember that after the entire industry burns thousands of productivity hours (not to mention lawyer time) in trying to define this stick in the eye. This is pure Google and pure, unadulterated Wyden. (We might call this the “Wyden loophole” but when it comes to loopholes, Senator Wyden is as fecund as the shad so that description wouldn’t narrow it down much.) Plus it’s the kind of “registration-based” thinking that is straight out of the Samuelson “Copyright Principles Project” and the much ballyhooed American Law Institute Restatement of Copyright, not to mention Lessig and Sprigman. But after all the handwringing, the pre-72 license is a big victory for the Restatement crowd and it’s the law of the land.

So–the MMA includes a Google “license” request for pre-72 recordings that allows a sound recording owner of a pre-72 recording to approve or disapprove a request for a noncommercial use of that recording. Sounds simple, right? Not so simple as the Copyright Office notice of inquiry confirms. It’s a ridiculously complicated loophole that may ultimately lead to no license being issued–and that’s when the handwringing will really begin.

However ridiculous this whole thing is, it is the law, so we must deal with it. We will have more to say about the proposed regulation in coming days, but a couple points jump right out–most importantly, the obligation on the user to clear the song in the recording before burdening either the Copyright Office or the sound recording copyright owner with a no-money clearance request.

But–musical works (aka songs) enjoyed all kinds of federal copyright protection prior to 1972, so the fact that a sound recording might be subject to the new loophole created by Senator Wyden says nothing about the song. So how does this fit together?

First, the Copyright Office needs to play a real vetting role in this process before the sound recording copyright owner even receives the request and there should be no direct communications between user and copyright owner. Let’s not repeat the mass “address unknown” NOI mistake.

Recall that the Copyright Office failed to vet any of the millions of “address unknown” NOIs for compulsory song licenses which allowed many of those notices to be filed improperly (in the millions, I would guess which sure sounds like a crime). This was such a debacle that it gave Big Tech a leg up in passing the MMA, rather than fix the mistake. We do not need a repeat performance of that catastrophe or even a curtain call.

But perhaps more importantly, there is no reason for anyone to spend a minute on these requests unless the user requesting the pre-72 license for a pre-72 sound recording can show that they have already obtained the rights for any musical work embodied in the pre-72 sound recording. All those hidden costs were well-covered in the CBO review of the MMA…oh, wait. They weren’t at all.

And, of course, when the MMA’s super-duper global rights database for every musical work ever written or that ever may be written is up and running in less than two years from now, it will be super duper easy to find these pre-72 songs, right? For free?

So why should anyone spend any time on a sound recording request if the song rights have not already been obtained since the sound recording is unusable without the song clearance and the song license is not included in the Wyden loophole? (So presumably an arms length market rate unless a compulsory license applies depending on the use, say sync or mechanical.) And there’s certainly no reason for a user to pay a Copyright Office examiner to review an application that cannot be consummated because the user has been unable to obtain the song rights. That would be unfair to the user.

If the user wishes to assert fair use as a defense to the rights of the song owner, then presumably they’d also assert fair use against the sound recording owner, too, so they problaby would not even apply.

Hence every application for the pre-72 use would almost by definition require a song license unless the work is already in the public domain (such as recordings of the traditional classical repertoire). Determining whether the song is in the public domain is exactly the kind of work the user should be paying the Copyright Office examiner to confirm.

So I’d say this “song first” approach makes sense, although I’m willing to be educated otherwise.

Like this:

I know it’s not very “modern,” but music piracy is still a huge problem. As recently as yesterday I had a digital music service executive tell me that they’d never raise prices because the alternative was zero–meaning stolen.

Very 1999, but also oh so very modern as long as Google and their ilk cling bitterly to their legacy “safe harbors” that act like the compulsory licenses they love so much. Except the safe harbor “license” is largely both royalty free and unlawful. Based on recent data, it appears that streaming is not saving us from piracy after all if 12 years after Google’s acquisition of YouTube piracy still accounts for over one third of music “consumption.” The recent victory over Google in the European Parliament indicates that it may yet be possible to change the behavior of Big Tech in a post-Cambridge Analytica world.

It’s still fair to say that piracy is the single biggest factor in the downward and sideways pressure on music prices ever since artists and record companies ceded control over retail pricing to people who have virtually no commercial incentive to pay a fair price for the music they view as a loss leader. If the Googles of this world were living up to their ethical responsibilities that should be the quid pro quo for the profits they make compared to the harms they socialize, then you wouldn’t see numbers like this chart from Statistica derived from IFPI numbers:

The good news is that there is a solution available–or if not a solution then at least a more pronounced trend–toward making piracy much harder to accomplish. It may be necessary to take some definitive steps toward encouraging companies like Google, Facebook, Twitch, Amazon, Vimeo and Twitter to do more to impede and interdict mass piracy.

Private Contracts: It may be possible to accomplish some of these steps through conditions in private contracts that include sufficient downside for tech companies to do the right thing. That downside probably should include money, but everyone needs to understand that money is never enough because the money forfeitures are never enough.

Antitrust Actions: Just like Standard Oil, the big tech companies are on the path to government break ups as Professor Jonathan Taplin teaches us. What would have been unthinkable a few years ago due to fake grooviness, the revolving door and massive lobbying spending all over the planet, in a post-Cambridge Analytica and Open Media world, governments are far, far more willing to go after companies like Google, Amazon and Facebook.

Racketeer Influenced and Corrupt Organizations Act Civil Prosecutions: “Civil RICO” claims are another way of forcing Google, Facebook, Amazon & Co. to behave. Google is fighting a civil RICO action in California state court. This may be a solution against one or more of Google, Facebook and Amazon.

As we know, streaming royalties typically decline over time due to the fact that the revenues to be divided do not typically increase substantially (and probably because of recoupable and nonrecoupable payments to those with leverage). At any rate, the increase in payable revenues is less than the increase in the number of streams (and recordings).

While it’s always risky to think you have the answer, one part of the answer has to be basic property rights concepts and commercial business reality–if you can’t reduce piracy to a market clearing rate, you’ll never be able to increase revenue and music will always be a loss leader for immensely profitable higher priced goods that artists, songwriters, labels and publishers don’t share be it hardware, advertising or pipes.

I strongly recommend Hernando de Soto’s Mystery of Capital for everyone interested in this problem. The following from the dust jacket could just as easily be said of Google’s Internet:

Every developed nation in the world at one time went through the transformation from predominantly extralegal property arrangements, such as squatting on large estates, to a formal, unified legal property system. In the West we’ve forgotten that creating this system is what allowed people everywhere to leverage property into wealth.

What we have to do is encourage tech companies to stop looking for safe harbors and start using their know-how to encourage the transformation of the extralegal property arrangements they squat on and instead accept a fair rate of return. My bet is that this is far more likely to happen in Europe–within 30 days of each other we’ve seen Europe embrace safe harbor reform in the Copyright Directive while the United States welcomed yet another safe harbor.

If we’re lucky, the European solution in the Copyright Directive may be exported from the Old World to the New. And if Hernando de Soto could bring property rights reform to Peru in the face of entrenched extralegal methods and the FARC using distinctly American approaches to capital, surely America can do the same even with existing laws and Google.

Subscription services are one of the few secular trends in the current economy that is not yet reactive to trade wars or interest rates.Subscription services are found in many areas of the economy, but music drives some of the big ones like Spotify, Amazon and especially the razor-and-razorblades plays like Apple.But per-stream royalties do not come close to making up for the CD and download royalties they cannibalize. Not only do subscription retail rates need to increase, but it’s also time for a major change in the way artist’s streaming royalties are calculated from what is essentially a market share approach to one that is more fair. (Listen to the Break the Business podcast discussion about the Ethical Pool that I had with Ryan Kairalla.)

Artists’ dismal streaming royalties on music subscription services are largely based on a simple calculation:A per-stream payment derived from a share of the service’s revenue prorated by number of streams.Artists get a portion of a service’s monthly revenue (at least the revenue the service discloses) based on a ratio of your plays to all the plays.Your plays will always be a lot smaller than the total plays.(This is essentially what Sharky Laguana referred to as the “Big Pool.”)

Sounds simple, but mixed with the near-payola of Spotify’s playlist culture and Pandora’s “steering” deals, it’s really not.Negotiating leverage allows big stakeholders to tweak the basic calculation with floors, advances (aka breakage), nonrecoupable payments that help cover accounting costs, and other twists and turns to avoid a pure revenue share.

It also must be said that stock analysts and venture investors always—always—blame “high” royalties for loss-making in music services.This misapprehension ignores high overhead such as Spotify’s 10 floors of 4 World Trade Center or high bonus payments such as Daniel Ek’s $1,000,000 bonus paid for failing to accomplish half of his incentive goals stated in the Spotify SEC documents (p. 133 “Executive Compensation Program Requirements”).

Of course all these machinations happen behind the scenes. Fans are not aware that their subscription pays for music they don’t listen to and artists they never heard of or don’t care for. Plus, it’s virtually impossible for any label or publisher to tell an artist or songwriter what their per-stream rate is or is going to be.

Fans Don’t Like It: A New Wave of Cord Cutters?

So neither fans nor artists are happy with the current revenue share model. Given that the success of the subscription business model is keeping subscribers subscribing, the last thing the fledgling services need are cord cutters.

Simply put, if a fan pays their subscription and listens to 20 artists in a month, that fan likely believes that their subscription is shared by those 20 artists and not by 200,000 artists, 99.99% of whom that fan never listened to and probably never will, similar to Sharky’s “Subscriber Pool.” (You can take a survey here.)

This is why some artists like Sharky Laguana (and their managers) have begun arguing for replacing the status quo with “user-centric” royalties that more directly correlate fan listening to artist payments. I have a version of this idea I call the “Ethical Pool.”

How Did We Get Here?

How in the world did we get to the status quo? The revenue share concept started in the earliest days of commercial music platforms.These services didn’t want to pay the customary “penny rate” (as is typical for compilation records, for example), because a fixed penny rate might result in the service owing more than they made–particularly if they wanted to give the music away for free to compete with massive advertising supported pirate sites.

Paying more than you make doesn’t fit very well with a pitch for a Web 2.0, advertising driven model:All you can eat of all the world’s music for free or very little, or “Own Nothing, Have Everything,” for example. It also works poorly if you think that artists should be grateful to make any money at all rather than be pirated.

Revenue share deals for big stakeholders have some bells and whistles that leverage can get you, like per-subscriber minimums, conversion goals, top up fees, limits on free trials, cutbacks on “off the top” revenue reductions, and the percentage of revenue in the pool (50%—60%-ish). Even so, the basic royalty calculation in a revenue share model is essentially this equation calculated on a monthly basis:

(Net Revenue * [Your Streams/All Streams])

Or ([Net Revenue/All Streams] * Your Streams)

In other words all the money is shared by all the artists.

Sounds fair, right?

Wrong.First, all artists may be equal, but on streaming services, some are more equal than others.Regardless of the downside protection like per-subscriber or per-stream minima, the revenue share model has an inherent bias for the most popular getting the most money out of the “Big Pool.” (This is true without taking into account the unmatched.)

And of course it must be said that the more of those artists are signed to any one label, the bigger that label’s take is of the Big Pool.So the bigger the label, the more they like streaming.

Conversely, the smaller the label the lower the take.This is destructive for small labels or independent artists.That’s why you see some artists complaining bitterly about a royalty rate that doesn’t have a positive integer until you get three or four decimal places to the right.Why drive fans away from higher margin CDs, vinyl or permanent downloads to a revenue share disaster on streaming?

Yet it increasingly seems that we are all stuck with the nonsensical streaming revenue share model.

Do Fans Think It’s Wrong?

There’s nothing particularly nefarious about this—them’s the rules and rev share deals have been in place for many years, mostly because the idea got started when the main business of the recorded music business was selling high margin goods like CDs or even downloads.Low margin streaming didn’t matter much until the last couple years.

It was only a question of time until that high margin business died due to the industry’s willingness to accept fluctuating micropennies as compensation for the low-to-no margin streaming business.(I say “no margin business” because the costs of accounting for streaming royalties may well exceed the margin—or even the payable royalty—on a per-stream basis when all transaction costs are considered as Professor Coase might observe.)

So understand—the revenue share model is essentially a market share distribution.Which is fine, except that in many cases, and I would argue a growing number of cases, when the fans find about about it, the fans don’t like it.They pay their monthly subscription fee and they think their money goes to the artists they actually listen to during the month.Which is not untrue, but it is not paid in the ratio that the fan might believe. Fans could easily get confused about this and the Spotifys of this world are not rushing to correct that confusion.

Here’s the other fact about that rev share equation: over time, the quotient is almost certain to produce an ever-declining per-stream royalty.Why?

Simple.

If the month-over-month rate of change in revenue (the numerator) is less than the month-over-month rate of change in the total number of streams or sound recordings streamed on the service (the denominator), the per-stream rate will decline over those months.This is because there will be more recordings in later months sharing a pot of money that hasn’t increased as rapidly as the number of streams.

As the number of recordings released will always increase over time for a service that licenses the total output of all major and indie labels (and independent artists), it is likely that the total number of recordings streamed will increase at a rate that exceeds the rate of change of the net revenue to be allocated. If there are more recordings, it is also likely that there will be more streams.

So streaming royalties in the Big Pool model will likely (and some might say necessarily will) decline over time.That’s demonstrated by declining royalties documented in The Trichordist’s “Streaming Price Bible” among other evidence.

Thus the fan’s dissatisfaction with the use of their money is already rising and is likely to continue to rise further over time.

User-Centric Royalties and the Ethical Pool

How to fix this?One idea would be to give fans what they want.A first step would be to let fans tell the platform that they want their subscription fee to go to the artists that the fan listens to and no one else.This is sometimes called “user-centric” royalties, but I call this the “Ethical Pool”.

When the fan signs up for a service, let the fan check a box that says “Ethical Pool.”That would inform the service that the fan wants their subscription fee to go solely to the artists they listen to.This is a key point—allowing the fan to make the choice addresses how to comply with contracts that require “Big Pool” accountings or count Ethical Pool plays for allocation of the Big Pool. Remember–the Ethical Pool exists along side the Big Pool, not to the exclusion of the Big Pool. If the fan did not opt in to the Ethical Pool, the default would be the Big Pool. Don’t miss this point, lots of people do.

Artists also would be able to opt into this method by checking a corresponding box indicating that they only want their recordings made available to fans electing the Ethical Pool.The artist gets to make that decision. Of course, the artist would then have to give up any claim to a share of the “Big Pool.”

Existing subscribers could be informed in track metadata that an artist they wanted to listen to had elected the Ethical Pool. A fan who is already a subscriber could have to switch to the Ethical Pool method in order to listen to the track.That election could be postponed for a few free listens which is much less of an issue for artists who are making less than a half cent per stream.

The basic revenue share calculation still gets made in the background, but the only streams that are included in the calculation are those that the fan actually listened to.If the fan doesn’t check the box, then their subscription payment goes into the market share distribution as is the current practice, but their musical selection is limited to “Other than Ethical Pool” artists.

That’s really all there is to it.The Ethical Pool lives side by side with the current Big Pool market share model.If an Ethical Pool artist is signed, the label’s royalty payments would be made in the normal course.The main difference is that when a subscriber checks the box for the Ethical Pool, that subscriber’s monthly fee would not go into the market share calculation and would only be paid to the artists who had also checked the box on their end.

One other thing—the subscription service could also offer a “pay what you feel” element that would allow a fan to pay more than the service subscription price as, for example, an in-app purchase, or—clasping pearls—allow artists to put a Patreon-type link to their tracks that would allow fans to communicate directly with the artist since the artist drove the fan to the service in the first place.I’ve suggested this idea to senior executives at Apple and Spotify but got no interest in trying.

The Ethical Pool is real truth in advertising to fans and at least a hope of artists reaping the benefit of the fans they drive to a service. There are potentially some significant legal hurdles in separating the royalty payouts, but there are ways around them.

I think the Ethical Pool is an idea worth trying.

UPDATE: I want to emphasize a couple points that seem to keep coming up in discussions about Ethical Pool.

Ethical Pool exists as an option to the Big Pool. If a fan doesn’t select the Ethical Pool, the default is the Big Pool. The Ethical Pool is a different pot of money that the Big Pool and is divided among fewer artists. Both exist at the same time.

If artists who are not rewarded by the Big Pool can offer their music at a higher margin somewhere other than the big platforms, they may just skip the Ethical Pool altogether and simply drive fans to the higher margin sites in more of a direct to fan relationship.

The two essential points of the Ethical Pool are (1) the Big Pool is a hyperefficient concentration of revenue to a small number of artists that trends toward a market share allocation and will always fail to reward niche and developing artists, and (2) that if the artist wantsto be on the big platform, they may have a better shot at getting a higher royalty with the Ethical Pool than the Big Pool.

Like this:

If you’ve ever asked yourself why Spotify has such a large market cap, I’d suggest there are a couple reasons. (One we can eliminate right away is that the company is actually worth today’s $34,880,000,000 valuation.)

We can discount as a correctable market distortion the fact that Spotify manipulated the SEC into allowing the company to take its private market sale price as an indicator of what its public shares should trade at (discounting that most of the private stock was likely sold by insiders on the private market who had an interest in propping up the valuation). We can also discount that the “direct public offering” resulted in shares being sold by insiders on the public market who had an interest in propping up the stock price and the implied valuation.

The only problem is that while the Peoples Republic of China can command a lot of stuff in their economy (if you can call it that), one thing Xi Jinping (who is General Secretary for Life of the Communist Party of China, President for Life of the People’s Republic of China, and Chairman for Life of the Central Military Commission) cannot control is the stock market. And the stock market is sending a signal about Tencent that Spotify would do well to pay attention to given the chunk of Spotify owned by Tencent. (Check quickly to see if any recordings of the Tibetan Freedom Concert are available on Spotify.)

Tencent is down 17% on the year and dropped a bunch yesterday from its first profit cut in 13 years because “it did not know when it would get Chinese approval to make money from its most popular game” according to Reuters.

That’s a good reminder of the facts on the ground for Chinese companies–if President for Life Xi Xinping doesn’t want you to make money, it can ruin your whole day. Read the Tencent earnings call transcript. And a squeeze on Tencent can also create some international or regional index fund torque that affects other big Chinese companies.

But the tale of the tape tells us that the problems started for Tencent quite some time ago–in January Tencent had a $575 billion market cap compared to $403 billion today, a lopping of some $170 billion–that’s billion with a “B”–off of its market cap. Which is indicative of the problems with the Chinese economy as a whole–not to mention that there’s a lot of domestic retail investing on margin in China and short selling.

And when the margin calls come in, that stuff is nasty no matter what geographical economy you live in (see The Big Short.)

So at the moment, it looks as if Tencent’s shares of Spotify are doing better for Tencent than Spotify’s shares of Tencent are doing for Spotify.

Like this:

The Music Modernization Act is definitely the gift that keeps on giving. It seems like every time I read it, a new toad jumps out from under a rock.

The latest one I found is a new burden the MMA places on all sound recording owners, large and small, to help the digital services comply with their obligation to locate song copyright owners in order for the services to keep the new “reachback” safe harbor also referred to as the “Limitation on Liability”. This is the retroactive safe harbor given effect on January 1, 2018 regardless of when the bill actually is passed by both houses of Congress and signed by the President.

Here’s the relevant clause (at pages 100-101 of the House bill):

REQUIREMENTS FOR LIMITATION ON LIABILITY.—The following requirements shall apply on the enactment date and through the end of the period that expires 90 days after the license availability date to digital music providers seeking to avail themselves of the [reachback safe harbor]:

‘(i) No later than 30 calendar days after first making a particular sound recording of a musical work available through its service via one or more covered activities, or 30 calendar days after the enactment date, whichever occurs later, a digital music provider shall engage in good-faith, commercially reasonable efforts to identify and locate each copyright owner of such musical work (or share thereof). Such required matching efforts shall include the following:

(I) Good-faith, commercially reasonable efforts to obtain from the owner of the corresponding sound recording made available through the digital music provider’s service the following information:

(aa) Sound recording name, featured artist, sound recording copyright owner, producer, international standard recording code, and other information commonly used in the industry to identify sound recordings and match them to the musical works they embody.

(bb) Any available musical work ownership information, including each songwriter and publisher name, percentage ownership share, and international standard musical work code.

And yes, that is a double “good-faith, commercially reasonable” predicate–a drafting bugaboo of mine. I guess it means really, really, really good faith and absolutely positively commercially reasonable since they said it twice.

So what this means is that labels are required to provide to digital services a lot of song ownership information that they may or may not have. For example, if the label licenses in a sound recording and puts the publishing payments on the licensor (very common practice) the information might be “available” but it is just not available to them.

Note that despite the fact that “good faith” and “commercially reasonable” are repeated twice for emphasis, those concepts modify the efforts of the digital service and not the efforts of the label to respond. (Not surprising, if you believe as I do that the MMA was largely written by the lobbyists for the services and not the publishers or songwriters.)

At a minimum, the clause should be revised to extend the “good faith” and “commercially reasonable” modifiers to the label’s efforts to provide song information. Having said it twice, why not three times?

There’s also no procedure for how this request is to be made or responded to, nor is there reimbursement of the costs incurred by the label in complying. There’s also no limitation on liability for the label if it provides the service what turns out to be incorrect information.

Of course, what should really happen is that the entire paragraph (bb) should simply be struck. It has long been the practice of record companies to refuse to provide publisher information to digital services and it has long been the practice of digital services to not ask for it.

In all likelihood, the services will engage a third party to do their song research, which is covered in the very next clause:

(II) Employment of one or more bulk electronic matching processes that are available to the digital music provider through a third-party vendor on commercially reasonable terms, but a digital music provider may rely on its own bulk electronic matching process if it has capabilities comparable to or better than those available from a third-party vendor on commercially reasonable terms.

Taking a long look at the clause, it seems reasonable to simply strike the entire clause (I) and keep the labels out of it as has long been the practice, and require the services to either use their own systems or hire a vendor. And that’s where there should be some criteria for what constitutes a proper vendor. If there’s going to be any work done by the labels, then–as advertised–the digital services should pay the label’s cost of compliance as part of the assessment and the label should have no liability if they happen to not have the song information “available”–in a commercially reasonable manner.

We all want the MMA to work, but we also all want to avoid unfunded mandates imposed by the federal government that create unintended consequences.

Like this:

SoundExchange’s new Music Data Exchange (MDX) is a promising idea that gets at a big part of the real problem with mass infringement of songs by digital services. It also gives some hope of actually reducing the “pending and unmatched” (or “black box” in the vernacular) at the source–before the songs are infringed.

Regardless of what the Music Modernization Act’s proposed blanket license and new retroactive safe harbor for infringing services may do, if the song ownership data isn’t available pre-release, it is unlikely that the proposed Music Licensing Collective will result in more efficient payments to songwriters subject to the blanket license.

When I worked at A&M Records, I established a policy of enforcing requirements in producer and artist agreements that writer and publisher information (including splits) be delivered to A&R Administration along with every new recording as part of the larger label copy process. A&R Administration then was able to send the full publisher and song metadata for the recording to the Copyright Department so that there was no need (or much less need) for them to chase down the information on new releases. That’s not only extremely inefficient, it also makes their job exceptionally frustrating and Kafka-esque.

This required putting some sensitive English on the ball, so to speak, about enforcing our contracts with the most important people on the label–the artists and producers. But it was a simple pitch–let’s get this right so that songwriters get paid properly. That resonated.

This policy resulted in A&M having the lowest pending and unmatched in the industry–to the point that on audit some people thought we were hiding something.

On balance, the downside of denying the black box slush fund just didn’t compare to the upside of making sure our songwriters got paid (many of whom also were our artists). While I’m glad that the plan worked for A&M at the time, what’s really needed in an era of massive infringement by digital services is an industry-wide solution that takes away that excuse.

Nobody likes litigation, but it has become a last resort when faced with people who just don’t seem to care and would rather buy themselves a new safe harbor than do the right thing. MDX may offer that opportunity and solution.

Hypebot recently published an interview with SoundExchange’s Jonathan Bender that gives a clear explanation of the goals and functionality of the service. I think it’s a solution that everyone should support.

And use.

…[I]t occurred to us that we were addressing a problem after it happened. We said, “Isn’t there a way to address the problem before it happens? Before you get to the point where you have settlements and lawsuits and unhappy writers and publishers?”

That was the core idea of Music Data Exchange – to create a centralized, rational process for labels to request publishing data and for the publishers to respond to those requests on a central site…

In one of my first meetings with one label’s copyright department I asked, “How do you get the publishing data?” They said they generate a report of all their new releases each week, typically hundreds of recordings, hand it to their copyright people, and then they commence to email publishers they know asking “is this your song?”

That’s just one label. Add hundreds of labels and hundreds of publishers to that, and thousands of recordings a week. It’s no surprise that it’s a mess.

Like this:

The famous old Russian proverb reminds us to trust but verify. That’s been the story in the record business since the cylindrical disc. All the “modernization” in the world will not soothe songwriter’s genetic suspicion of their accounting statements.

The collective to be established by the Music Modernization Act (“MMA”) undertakes the obligation to handle other people’s money. It quickly follows that those whose money the collective handles need to be able to verify their royalty payments from time to time. This has been an absolutely standard part of every royalty-based agreement in the music business for a good 50 years if not longer.

But like every aspect of the MMA, one has to always remember that while all songwriters may be equal, some songwriters are more equal than others. The MMA creates a two tier system–those who opt out of the compulsory blanket license by the mutual agreement of a rights owner and a digital service in the form of a voluntary agreement and those who do not. Those who do not have this opt-out right appear to receive payment directly from the collective instead of directly from the service–adding another set of hands and transaction costs. (It must be said that this group receiving payment under the compulsory blanket license will presumably also include those who currently have a voluntary license with digital services that is not renewed in future.)

The collective undertakes the responsibility of accounting should anticipate concerns of songwriters regarding verifying the accuracy of the statements and payments it renders. However, the MMA provides no supervisory oversight and in my view has a rather punitive black box clause that allows “unmatched” royalties to be paid on a market share basis to publishers, and then on to their lucky songwriters pro rata. This suggests that everyone who is in that lucky songwriter’s chain, like managers, business managers and lawyers working on a percentage basis may also get a share of these black box distributions in compensation.

So on the face of it, the MMA creates a relatively large category of people who have an economic interest in the black box. You can be cynical and think that they have an interest in the black box being as large as possible (meaning the accounting controls are as weak as possible), or you can agree with five-time Grammy winner Maria Schneider that if the “lucky” songwriters actually knew that they were being paid with money that belonged to the “unlucky” songwriters, they would be angry about that unfairness. Emphasis on the “actually knew”.

Or you could say, let’s not go either direction–let’s set up transparency and controls so that the incentives are properly aligned to create the smallest black box possible. No publisher needs the writer-relations headache of suspicious minds, and the collective should do what it can to be above reproach. Here are a couple solutions to increase the trust level: Add oversight of the collective by the Office of the Inspector General (as a quasi-governmental organand at least designated by the Copyright Office and operating under the control of the Copyright Office, and also tighten up the audit clauses in the MMA to treat songwriters auditing the collective the same as the collective is treated by the digital services.

The Inspector General

One way to make sure that the collective–a quasi governmental organization in my view–is run honestly is to make it subject to oversight review by one of the U.S. Government’s many Inspectors General. Rick Carnes of the Songwriters Guild of America suggested this to Rep. Doug Collins at the University of Georgia Artist Rights Symposium in a question from the floor.

For example, the Library of Congress (currently where the Copyright Office is housed) has an Inspector General. Since the Copyright Office has a lot to do with the creation and periodic review of the collective, they could save themselves a bunch of Freedom of Information Act requests from angry songwriters by having an Inspector General review the collective annually (or better yet, in real time).

My understanding is that giving an IG jurisdiction over the collective will require some enabling legislation, but I think it’s something well worth looking into. It would give the songwriters of the world a true-blue fiduciary to represent their interests as well as comfort that they had a line of appeal with some teeth short of expensive litigation.

Audits

The Inspector General is not in the current draft of the MMA, but audits are–both audits of the collective by songwriters and audits by the collective of digital music services. We’ll focus on audits of the collective in this post. It should be said that under the current compulsory license now in effect (i.e., pre-MMA), songwriters get no audit right, so the fact that there is an audit right at all is an incremental improvement.

Unfortunately, the MMA’s audit right still keeps songwriters away from auditing the right party–the digital services–and keeps that upstream data away from them. Plus, all audits under MMA appear to be subject to confidential treatment. I don’t think there’s a good reason to keep these secret. If a smart auditor finds a flaw in the collective’s accounting systems, that flaw should be disclosed and there should be an automatic true up of everyone affected.

But first, let’s realize what an “audit” actually is. It is a term of art in the music business and really means a “royalty compliance examination” which is solely focused on making sure that statements and payments rendered conform to the contract concerned, or in this case, the statutory requirements of the compulsory blanket license.

(It also must be said that as Maria notes, the MMA specifically exempts the collective from any responsibility for incompetent royalty accounting other than “gross negligence”, which usually means blatant indifference to a legal duty or something along those lines–assuming the collective’s board or employees actually have a legal duty to account correctly which it may not.)

The person conducting a royalty audit is typically not a certified public accountant as there is nothing about conducting this examination that requires a knowledge of Generally Accepted Accounting Principles (“GAAP”), financial accounting, or Sarbannes Oxley compliance. It is, in fact, quite rare for a royalty audit to be conducted by a CPA, and I’ve even had lawyers conduct an audit because the analysis involved is mostly that of contractual, or statutory, interpretation. Analysis of music industry-specific contracts is typically not part of the training of CPAs. So even if an auditor is a CPA, the skills needed to conduct the audit are typically learned through on the job training.

What is very common, however, is for someone on the receiving end of the audit to try to require the auditor be a CPA, arguably to increase the cost of the audit on the person owed money. CPAs often bill at higher rates than do royalty auditors, which creates a disincentive for audits. What is also common is for lawyers to think that every time they draft a clause about anyone conducting anything having to do with accounting, that they need to limit the person doing that examination to a CPA, because…well, because… This is what I call stupid lawyer tricks, and the CPA requirement is something that is routinely negotiated away in record deals and publishing deals if you have an ounce of leverage.

Here’s the preamble of the MMA’s audit clause for audits of the collective:’

A copyright owner entitled to receive payments of royalties for covered activities from the mechanical licensing collective may, individually or with other copyright owners, conduct an audit of the mechanical licensing collective to verify the accuracy of royalty payments and distributions by the mechanical licensing collective to such copyright owner

Remember–copyright owners under the compulsory are not allowed to audit the service, although the collective may audit the service. (And, of course, voluntary agreements are governed by their terms regarding audits and are not subject to the compulsory.)

Limiting the audit right to “copyright owners entitled to receive payments” means that if songwriters have an administration or co-publishing agreement, they will probably not be able to conduct an audit of the collective (even if their administrator or co-publisher is a board member of the collective). Because the audit is limited to “verifying the accuracy” of prior payments, the audit of the collective will not be able to look “upstream” to the service making the payment and may not be able to look at payments made to the collective, just the payments by the collective.

The audit shall be conducted by a qualified auditor, who shall perform the audit during the ordinary course of business by examining the books, records and systems of the mechanical licensing collective, as well as underlying data, according to generally accepted auditing standards and subject to applicable confidentiality requirements prescribed by the Register of Copyrights…

Again, I don’t think that the auditor needs to be both a CPA and have experience. Experience is enough. For example, if the auditor has performed audits for members of the collective’s board of directors, perhaps that would be enough.

The qualified auditor shall determine the accuracy of royalty payments, including whether an underpayment or overpayment of royalties was made by the mechanical licensing collective to the auditing copyright owner(s); provided, however, that before providing a final audit report to such copyright owner(s), the qualified auditor shall provide a tentative draft of the report to the mechanical licensing collective and allow the mechanical licensing collective a reasonable opportunity to respond to the findings, including by clarifying issues and correcting factual errors.

This clause is a problem. First, the auditor is hired–and has a professional duty–to find underpayments of royalties. That’s what they look for. The auditor does not have a duty to do the collective’s work for it and find overpayments. The auditor is not hired to find overpayments, they are hired to find underpayments.

The collective should hire its own accountants to review its royalty statements, and it surely will do so if it gets an audit notice. Otherwise the US Government is placing a heavy burden on the auditor and the copyright owners to look for overpayments as though the auditor played the role of a public financial accounting firm looking for accuracy on behalf of stockholders.

Plus, the requirement to force that auditor to give the collective the audit report before giving it to the people who hired that auditor is a bit much. Fair enough to meet and confer at the work paper stage to make sure there weren’t inaccuracies in the analysis, but that should not place any prohibition on whether the auditor’s own client can see the report first.

If this is really the role that the Government wants the auditor to play, then by all means let’s make any miscalculations by the collective available to the public and publish them in the Federal Register. Let’s not have the auditor’s findings subject to any confidential treatment. If that brings down a host of other audits or a need to restate millions of royalty payments, then so be it. Because we are not just looking for underpayments we are searching for the truth, right?

I don’t think so. And the next part of the audit clause shows why:

The auditing copyright owner(s) shall bear the cost of the audit. In case of an underpayment to the copyright owner(s), the mechanical licensing collective shall pay the amounts of any such underpayment to the auditing copyright owner(s), as appropriate. In case of an overpayment by the mechanical licensing collective, the mechanical licensing collective may debit the accounts of the auditing copyright owner(s) for such overpaid amounts, or such owner(s) shall refund overpaid amounts to the mechanical licensing collective, as appropriate.

Like so many other parts of the MMA, this is essentially an “ad terrorem” clause, or a right coupled with a penalty if it is exercised. What I think this means is that regardless of how much the underpayment might be–including both a material and nonmaterial amount–the songwriter bears 100% of the cost of the audit. The songwriter’s auditor has to look for overpayments (and bill their client for that extra review), and if the auditor finds any, the auditor has to report the overpayment. The songwriter then not only has to repay that amount (whatever “as appropriate” means), but also pay for the expense of finding it.

Compare this to the rights of the collective when auditing a digital music service:

The mechanical licensing collective shall pay the cost of the audit, unless the qualified auditor determines that there was an underpayment by the digital music provider of 10 percent or more, in which case the digital music provider shall bear the reasonable costs of the audit, in addition to paying the amount of any underpayment to the mechanical licensing collective. In case of an overpayment by the digital music provider, the mechanical licensing collective shall provide a credit to the digital music provider.

So what’s good for the goose is not good for the gander. When the collective is auditing upstream, the collective gets the benefit of that standard underpayment penalty. That means that the service has to pay for the cost of the audit if the underpayment exceeds a fixed percentage, in this case 10%. If there is an overpayment, the collective never has to repay the overpayment, just credit the account with an offsetting amount.

There should be no obligation on the part of the songwriter to have to find overpayments and if an overpayment is found in the normal course, it should simply be credited (which is the effect of the collective’s audit clause on songwriters downstream).

Songwriters should get the same underpayment protection on audit costs that the collective enjoys.

Appointing an Inspector General and cleaning up the audit clause would certainly make the MMA more fair for songwriters than it currently is.